Bengaluru, June 22 : The government should infuse capital in state-run banks to enable them to support credit growth, Reserve Bank of India (RBI) Governor Raghuram Rajan said on Wednesday.

"Governments are sometimes reluctant to infuse bank capital because there are so many compelling needs for funds. Yet, there are few higher return activities than capitalising the public sector banks so that they can support credit growth," Rajan said at an interactive session with captains of industry and trade here.

Admitting that capital infusion into weak banks should accompany an improvement in (their) governance, Rajan said given the need for absorbing the losses associated with balance sheet clean-up, the government should infuse its capital quickly.

"If the government cannot buy bank equity directly with cash, it is for it to issue the banks Government Capitalisation Bonds, in exchange for equity. The banks would hold the bonds on their balance sheet. This would tie up part of their balance sheet, but would certainly be capital," Rajan said addressing about 300 members of the Assocham trade body on 'Resolving Stress in the Banking System'.

Disagreeing with the economic survey's suggestion that the RBI should capitalise state-run banks, the RBI governor said getting the banking regulator once again into the business of owning banks with attendant conflicts of interest would be a non-transparent way of proceeding.

"Better that the RBI pay the government the maximum dividend that it can, retaining enough surplus buffers that are consistent with good central bank risk management practice," Rajan said in defence.

In this context, Rajan said the central bank had increased the dividend significantly and paid Rs 1,50,000 crore to the government in the last three years.

"In the last three years, we have paid our surplus to the government. The government should use this amount (from dividend) to infuse capital in its banks. Separately, the government can infuse capital into the banks. The two decisions need not be linked," Rajan pointed out.

Noting that the government was in the process of speeding up the debt recovery process and creating a new bankruptcy system, Rajan said the twin steps would improve the resolution process.

"The first is to improve the governance of public sector banks so that we are not faced with this situation again. The Government, through the Indradhanush initiative, has sent a clear signal that it wants to make sure that public sector banks, once healthy, stay healthy," he asserted.

Similarly, breaking up the post of chairman and managing director, strengthening board and management appointments through the banks board bureau, decentralising more decisions to the professional board, finding ways to incentivise management will help improve loan evaluation, monitoring and repayment.

"The cleaning up of bank balance sheets and restoration of credit growth are vital, as they are related elements in the growth agenda. The government and the RBI are helping our public sector bankers in this difficult but critical task. I know the process is working, so public sector banks will soon be set to finance the enormous needs of this economy once again," Rajan added.